ECB cuts deposit rate, due to unveil further measures

December 3, 2015 (Source: Reuters) — The European Central Bank cut one of its interest rates and promised to unveil more policy measures on Thursday to fight stubbornly low inflation, testing the limits of monetary policy and hoping to bolster its credibility.

Making good on its promise to do what it must to boost inflation “as quickly as possible”, the ECB lowered its deposit rate deeper into negative territory and said President Mario Draghi would announce further measures at his 1330 GMT news conference.

With inflation running near zero and likely to miss the bank’s target of nearly two percent for years to come, the ECB had all but committed to action, leaving investors guessing only what measures it would pick from an exceptionally long and sometimes contentious list.

It cut its deposit rate as expected to -0.3 percent from its existing -0.2 percent, charging banks more for parking cash with the central bank, reversing its earlier guidance that rates had bottomed out.

It is also seen extending its asset purchases beyond next September and increase monthly buys of mostly government bonds to 75 billion euros (£53.4 billion) from 60 billion euros.

The euro firmed close to 1 percent on the announcement as some market players expected an even bolder rate cut and as it left its other two key rates, the refinancing rate and the marginal lending rate unchanged.

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The bank’s governing council was also expected to have discussed more extreme ideas, possibly a two-tier deposit rate that would punish banks parking too much cash with the central bank or the purchase of municipal and corporate debt.

But many of those proposals were unlikely to gain traction as the inflation outlook is deteriorating only modestly and the recovery, though tepid, is proving to be resilient to the emerging market slowdown.

Critics of easing, led by the Governing Council’s two German members, argue that monetary policy is already exceptionally loose and the biggest reason inflation is hovering near zero is the fall in oil prices, which is a boost for growth as lower energy costs leave households with more to spend.

The U.S. Federal Reserve’s expected interest rate hike this month also complicates the decision. Fed Chair Janet Yellen said on Wednesday she was “looking forward” to a U.S. interest rate rise but an unexpectedly weak manufacturing survey this week has also raised fresh doubts about the Fed’s rate path.

Indeed, business activity in the euro zone picked up at its fastest pace since mid-2011 last month, third quarter economic growth was running at a respectable 1.6 percent and lending is increasing at the quickest rate in four years.

But top ECB officials, including chief economist Peter Praet, have focused their efforts on inflation, warning that missing the target again risked damaging the ECB’s credibility and making monetary policy less effective.

The bank is expected to lower its 2017 inflation forecast to 1.6 percent from 1.7 percent, a relatively minor adjustment but the second straight cut, supporting calls for action.

Even if oil prices account for part of the problem, core figures, which strip out energy prices, are running at half of the target, an indication that once the one-off effect of the crude price fall passes through, inflation will not rebound, they argue.

Still, the improved economic outlook means the ECB can also afford to save some firepower for later, especially after promising data, including lending growth at a four-year high.

And while critics say that cutting rates breaks the bank’s forward guidance, the ECB argued that Switzerland and Denmark moving rates deeper into negative territory actually lowered the floor rates, so it is not the ECB breaking its word but instead “lower bound” moving lower.

Analysts expect the ECB to learn from its mistake and predicted that it would no longer give a specific forward guidance and instead say that rates would stay exceptionally low for an extended period.

It could also make its asset purchases open-ended, removing the reference to an end next September and maintaining the scheme until there is a sustained upswing in inflation.